Friday, August 5, 2011

So Predictable

From the Desk of Joe Rollins

While readers of the Rollins Financial Blog are probably interested in my thoughts regarding yesterday’s substantial market sell-off, I’d already written the following month-end report. Blogs must be posted by 3:00 p.m. to be emailed to subscribers the same day, so my thoughts regarding the market sell-off will be published tomorrow, Saturday, August 6th. In the meantime, I thought it was still relevant to provide you with my opinions concerning the debt ceiling crisis and the market results for the month of July. So without further ado…

As I accurately predicted in my STAY FOCUSED post, on August 2nd Congress and White House leaders finally came to an agreement on increasing the debt ceiling just in the nick of time. Our incompetent leaders made it very easy for me to forecast that turn of events, as it seems like the most important agenda item for each of them is campaigning for another term and not looking out for what’s best for our country.

While the Tea Party members of Congress have been greatly criticized, I am grateful to them. Without them, there would be no conversation regarding reducing federal expenditures. Even though the amount approved was essentially just a token amount, it at least started the conversation that will ultimately have to be addressed in the upcoming budget conversations.

What bothers me the most is that on Tuesday, the Democrats, Republicans and the President were all in a circle singing “Kumbaya” about the great job they did in reducing federal expenditures. I think a more important discussion would be exactly what they really did. If you recall, the federal debt limit was increased by $2.4 trillion just to get through the 1st of November, 2012 election. Think about that reality for a second. If they needed to increase the federal deficit by $2.4 trillion over the next 15 months, that tells you they really intend to spend exactly that much money – more than they receive – between now and then. This means more debt.

Without the Tea Party’s intervention, I am sure the amounts would have been even greater, but at least there is a conversation and discussion regarding bringing these amounts under control. I will discuss the budgetary process for the next fiscal year later in this post, but I also wanted to discuss the month of July and the equity markets.

For the month of July, the S&P 500 was down 2% along with the Dow Industrial Average down a like amount. The NASDAQ was down .6% for the month. What’s interesting about the results of the month of July is that for the final week of July, the S&P 500 was down approximately 4%. If it hadn’t been for this severe sell-off, the month of July actually would’ve been up. With all you hear in the media regarding the negative stock market, I doubt you rarely hear anyone indicate that July was still a very satisfactory month for stock market performance.

The first week of August has been an altogether different situation. Due to the complete incompetence of Congress, the markets have essentially lost confidence in Washington’s ability to govern. Even though the debt ceiling was increased and signed on Tuesday, the major market indices sold off at 264 points on the same day. I received a great many questions asking why the market continues its massive sell-off when the deal was done.

In fact, the reason had nothing to do with an event that was totally predictable, but had everything to do with the banks in Italy announcing that they were essentially insolvent. It appears now that all of Europe is on the verge of financial calamity, and only Germany and France have the financial resources to support the rest. Isn’t it interesting that so many in the United States want us to be like Europe, but if anything, Europe is much worse off than we are.

I always wonder why people who invest in Treasury bonds wouldn’t make a similar investment in something like the Coca-Cola Company. The dividend rate on the Coca-Cola Company is 2.8%, which is higher than the current return on the 10-year Treasury. Additionally, you would be buying one of the great franchises in the world along with the potential for the stock price to go up. People who are making financial decisions to buy 10-year Treasury bonds today are not making that decision for investment purposes, but rather, for trading purposes. We focus our practice on investing, not on trading.

Even though Congress has approved “reductions of federal expenditures of over $2 trillion over the next decade,” even with these cuts, the federal deficit is projected to exceed $18 trillion over this timeframe. Essentially, this country is running the risk of financial calamity if it doesn’t address the massive overspending that has occurred in Congress over the last five or six years. It should also be very clear to you from this most recent debate on increasing the debt limit that the administration and the Democrats in Congress intend to keep spending as quickly as they can for as long as they have electoral control. It’s going to be interesting to see the new federal budget debate, which must be completed before September 30th, and exactly what the Congress approves.

What is most interesting about the budget debate is that there was never a federal budget approved for the fiscal year in which we are in. While the President submitted a budget to Congress in February for 2012, it was voted down in the Senate by a majority vote, including all members of his own party. The House approved a budget which was not even considered in the Senate. Now we are facing a deadline of September 30th for a new budget and Congress will not even be back in session until after Labor Day. If you thought political theater was bad on this most recent national debt increase, wait until the budget comes up in September.

You may rest assured that the political theater that we suffered through during the debt ceiling increase will only be a token amount as compared to what we see in the budgetary process. Since the country so clearly desires a smaller federal government, it should be a gigantic struggle between those that want to spend and those that want to save.

It appears that the U.S. economy is, in fact, quite stable. Contrary to what is being reported in the media, employment is improving, interest rates are low, and profits are skyrocketing. It is almost exactly the opposite of what is going on in the Eurozone. Seemingly, all of the European countries that have supported the “cradle to grave” mentality of the government taking care of its citizens are now failing one at a time – first Greece, Portugal and Ireland, and now the larger economies of Spain and Italy. The major effect on our markets has more to do with the failure of Europe than the failure of the U.S. economy.

Isn’t it fascinating that 2009 began with the political commitment to make the U.S. more like Europe? Fortunately for us, before Washington could implement a “cradle to grave” philosophy in the United States, the model on which it was based has completely imploded. It doesn’t take a rocket scientist to understand that bigger and bigger government can’t be financed by fewer and fewer taxpayers. Now that they’ve discovered that in Greece, Portugal, Ireland, Spain and Italy, maybe we’ll get the hint here in the U.S. without going through the destructive phases.

Unlike the European banks, the United States recapitalized all of its banks in the last three years that are ultra-strong and ultra-well-funded. Virtually none of the banks in Europe have that economic cushion.

This is not to say that things are rosy in the United States, but they are stable. As I view things today, it’s almost impossible to assume that the U.S. would fall into another recession given the economic conditions of today. However, it would not be unheard of for the recession occurring in other parts of the world to drag the U.S. “kicking and screaming” into a like financial situation. But that’s not something I am foreseeing.

More tomorrow…

As always, the foregoing are my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.

Best regards,
Joe Rollins

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